In the aftermath of its 2003 invasion of Iraq, the United States was eager to restructure the struggling country’s sovereign debt. International sanctions since the Gulf War meant that Iraq was economically isolated, but the country had a large stock of unpaid debts to governments, financial institutions and trading partners that dated back to its wartime arms purchases from Iran. -Iraq 1980.
In the early 2000s, Iraq was the most indebted country in the world, with debt amounting to 573% of GDP. This debt, and the war it financed, transformed it from a prosperous nation to a war-torn and insolvent nation in just a few years. Scandals have surrounded Iraqi creditors, who have been accused of everything from illicit money flows to secret arms sales. In the long term, this debt was a major obstacle to international trade. In the absence of restructuring, former creditors could seize commercial or sovereign assets to recover their money, as they had done in previous defaults.
Iraq’s debt stock is a glaring example of “odious” or illegitimate debt – a notion that dates back to the 1898 peace negotiations of the Spanish-American War. At the time, the Americans claimed that neither they nor the Cubans were responsible for Cuba’s outstanding sovereign debt. On the contrary, they argued, since the debt had been imposed on Cuba by the Spanish colonial rulers, it must be understood as illegitimate.
Since then, attempts have been made to define an explicit legal doctrine of legitimate debt, but the adoption of such a doctrine has remained rare in international negotiations. Today, the concept of odious debt is best viewed as a principle rather than a defined set of international laws. He argues that debt issued without public consent and serving no public purpose at the time of issuance should not be inherited by successive governments. This, however, goes against key principles of international law, which hold that the issuance of debt depends on the apolitical durability of bonds.
But even within the existing international framework, countries do not always repay their debt. The number of sovereign debt defaults and restructurings has increased along with the level of debt. Debt crises are still dealt with on a case-by-case basis, and the international monetary system is unprepared for the array of economic and political crises that continue to unfold. In this context, the notion of odious debt gains in urgency, both in the conceptualization of sovereign debt crises and in the fight against their serious consequences. Iraq and Haiti present two key examples.
Iraqi debt restructuring
Iraqi sovereign debt was issued to wage a geopolitical war that is irrelevant to the vast majority of Iraqis. During the American invasion in 2003, there were strong arguments not only to restructure the debt, but simply to cancel it. This was the position of many grassroots groups who called for a debt jubilee. Surprisingly, it’s a proposal that has even received support from the Department of Defense and the White House, institutions that rarely intervene in sovereign debt management matters. While the US government has never presented a coherent vision, many US officials have recognized that success in Iraq hinges on its integration into international trade.
Although they do not follow a model, sovereign debt restructurings always involve distinct actors: the government of the debtor country, normally represented by the minister of finance or the governor of the central bank, aims to streamline the process and maximize relief. On the creditor side, there is a patchwork of committees: Western countries negotiate collectively in the Paris Club, while commercial creditors tend to form working groups based on industry, geography or type of debt. Bankers and lawyers represent each group, and the IMF provides credibility (debt sustainability analyzes and balance of payments data) as well as bridge financing. In the Iraqi case, the US Treasury was heavily involved in the discussions thanks to the political commitment of the US government.
Despite the moral and economic rationale for debt cancellation, the IMF, finance ministries around the world, lawyers and bankers all had an incentive to resist the invocation of odious debt for two reasons. First, it would disrupt the normal order of sovereign debt restructurings, potentially making other claims susceptible to challenge. Second, in the case of Iraq, political support from the United States meant that normal debt restructuring could be carried out quickly and powerfully.
The global financial community argued that a standard restructuring would be easier than developing a new doctrine. Because there was strong political support from coalition governments to cancel Iraq’s debt, they turned out to be right: the subsequent restructuring was successful and Iraq’s debt was reduced by almost 90 % in terms of net present value. Most governments signed on and commercial creditors accepted the deal. The deal offered a 20% return on nominal claims plus interest. Because the debt was so old at the time of the restructuring, interest had accrued and creditors received high returns. Loans that had been written off were held at the same rate on the balance sheets as non-performing loans.
The standard restructuring allowed creditors to settle their debts and avoid uncomfortable questions surrounding its issuance. But above all, the Iraqi government was not at the table. The case demonstrates the complexity of officially recognizing a debt as illegitimate – even if an odious debt is identified and agreed upon, the political will to cancel it tends to be lacking.
Haiti’s independence debt
Between 1825 and 1950, Haiti paid 150 million francs to France. Following the slave revolt that led to Haiti’s declaration of independence in 1804, the fledgling former colony was forced to pay a huge “indemnity” to its former oppressor. It was also obliged to grant preferential treatment to French exports. To repay its creditors, Haiti had to borrow massively from French banks, securing its debt for generations. War reparations are normally imposed by the victor, but in the case of Haiti a different logic prevailed. Rather than the Haitian people or government demanding reparations from their former French masters, it was France that demanded compensation for the loss of its former colony and its slaves. According to an estimate by Kim Oosterlinck, Ugo Panizza, Mark Weidemaier and Mitu Gulati, compensation payments were equivalent to 270% of Haiti’s GDP.
Although Haiti won its independence, it was quickly crushed by foreign debt. The exorbitant sums have crippled the Haitian economy, hampering domestic and foreign investment, while cementing the status of a small elite. Oosterlinck and his co-authors calculate that if the indemnity had been invested with a real return of 1% since 1825, it would be equivalent to 22% of Haiti’s GDP today.
Today, Haiti is one of the poorest countries in the world and the calls for redress are increasing. Before the overthrow of President Aristide in 2004, Haiti was preparing a lawsuit against France for the restitution of the debt. The claim was and is substantial; the indemnity and associated loans were not made for the benefit of the Haitian people, but for the benefit of Parisian bankers, French exporters, and (later) New York banks. Haitian elites won recognition of their property rights, but the vast majority of Haitians suffered.
The cases of Iraq and Haiti illuminate the continuing importance of odious debt, from colonization to modern warfare. In Iraq, creditors lent money to buy weapons, financing a war fought in someone else’s name. In Haiti, the French gunboats were located outside the capital until the signing of the indemnification agreement, securing deep debt for generations. In both cases, coercion and force played a central role in imposing an odious debt. As in other cases, a small group of elites benefited from the loans, but they never reached the general public.
What happens afterwards?
The question of odious debt poses a fundamental question: how to design a system in which corrupt loans can be written off, without completely destroying the foundations of sovereign debt lending? Almost twenty years have passed since the restructuring of the Iraqi sovereign debt, but no progress in the development of a usable doctrine has been proposed. Likewise, more than 200 years after the imposition of its independence debt, Haiti ceased its efforts to file a complaint against France. If these two glaring cases of odious debt cannot serve as a basis for reform, there seems little hope of tackling the problem of illegitimate debt.
To design an odious debt doctrine, it is essential to ensure the ability to distinguish between illegitimate and legitimate debts. Not all loans should run the risk of being labeled illegitimate – the ability of debtors to tear up loan agreements without proper justification would pose a problem for the sovereign debt market as a whole. Bond contracts are drafted with cross-default clauses on a country’s “external debt”, often governed by English or New York law. If a country chooses to default on one creditor, it almost always results in an automatic default on all other creditors as well. This means that if a country borrowed money from a bank to build torture facilities for dissidents of its previous regime, but also borrowed money from a pension fund to build wind turbines, then it is difficult to repay the pension fund but not the bank. Reform is clearly needed in this regard. Recognizing the odious debts would mean that a court could designate the loan for the construction of torture facilities as illegitimate, thus allowing the country to go back on a specific loan and remain in good legal position without any second-order contractual problems.
But even this reform faces major political obstacles. Powerful agents of the global economy have no interest in developing a working doctrine of odious debt; many investors and banks have given loans to corrupt regimes and despots, and creditors like to be repaid. A standard that relies on Paulie’s repayment rule is obviously a standard that creditors want to maintain. So far, very few sovereign debt restructurings have involved a discussion of the moral dimension of paying creditors. But as the global debt crisis worsens in the years to come, such considerations are likely to become indispensable.